Seeds of Growth

Why the global savings glut boosts the case for global equities

 What determines the level of real interest rates? The principles of orthodox monetary policy are so well entrenched as to be virtually sacrosanct. Yet, as the timing of the first US rate rise is pushed out again, it is pertinent to question the validity of bedrock monetary assumptions after five years of record low interest rates.

Why? Because the implications for asset allocation will be significant.

There are two schools of thought on the forces that determine real interest rates. On one side, there is central-bank monetary orthodoxy that says the business cycle will reassert itself and rates will normalise, with perhaps 2% inflation and 2% interest rates in the US. Contrasting that, there is a loose group of economists who suggest there is a deficiency in aggregate demand that keeps real interest rates low due to the presence of a global excess of capital or a “savings glut”.

While there are some differences in the theories put forward by the counter-orthodox camp, the concept of a savings glut is a central theme. This scenario describes a world where too much capital is chasing too little income. This realisation has profounds implications for asset values and asset allocation. Indeed, if we are to remain in a world in which nominal and real yields feel the downward force of excess savings, then there are four key factors that investors should consider.

The first is that in a world where too much capital chases too little income, tomorrow’s returns are effectively being brought forward to today. The second is that as future returns are capitalised today, the gap between the present and future value of assets will narrow. The third is that as the gap between present and future values narrows, then the greatest risk that investors face is not short-term capital loss, but the risk that maturing investments will be reinvested at an ever-lower rate. This reinvestment risk works against market-timing strategies. Finally, as the gap between present and future values narrows, the factors influencing future values in discounted-cash-flow models become increasingly important. These factors are duration, the forward-looking investment rate and terminal values. These four forces suggest three key investment strategies on the part of investors.


The first strategy is that in a savings-glut environment, investors should be wary of stocking up on short-duration investments to protect against an interest-rate cycle that is persistently delayed and forecast to be benign. Rather, investors should build portfolios around core allocations to long-duration real assets such as equities and real estate.

The second strategy is that as reinvestment risk mounts, the focus will move to asset classes that can reset the reinvestment rate in nominal terms over time. Again this implies investors should steer towards property with the capacity to boost rental income or equities that pay dividends.

Strategy three is that, in a world of excess savings, where values will be under pressure as low real interest rates point to lower real returns on all assets (i.e., lower beta), investors must invest in innovative areas of the economy that can offer rising productivity, a real return on capital and a demonstrable addition to economic value. At present, this means investing in the US economy and in intangible intellectual property sectors such as pharmaceuticals, biotech, software and media.

Financial information comes from Bloomberg unless stated otherwise.
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